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Recently, Forbes magazine had an exposé on Why It’s OK to Rent Forever.  I’ve included a summary of that article and added some additional ideas of my own.

Owning a home can be a feel-good experience, for many reasons:

1. It’s tangible. 100 shares of Acme stock just doesn’t provide the same pride of ownership.
2. Housing is an effective inflation hedge.
3. You’re more likely to hear friends and family discussing home ownership versus most other investments.
4. The recent track record of home performance has been strong.

Yet there are downsides to home ownership.  Some owners feel anxiety over carrying significant debt and constrain themselves from other opportunities and pleasures in a rush to pay down that debt.

But what about renting?  Doesn’t that equate to throwing your money away?  But what’s the difference between throwing your money away on rent versus throwing your money away on mortgage interest?  In the good old days, when mortgage rates were low, the portion of the payment dedicated to paying down principal was higher.  However, as interest rates get higher, something called the yield curve gains a greater slope.  That means as interest rates go up, not only does the payment become higher, but the earlier payments toward the loan have a smaller portion of principal.  Throwing away money on interest is no better than throwing away money on rent.

Another factor to consider is the average cost of rent versus home ownership.  Often, the cost of homeownership is higher.  That means your monthly payment to own may be higher than the monthly payment to rent.  If paying rent or interest equates to throwing money away, home ownership is the better economic option if the amount of annual principal reduction is enough to balance out the larger monthly payment required of ownership.  If not, perhaps renting is the better choice.

An example might be helpful.  Consider a three-bedroom 2 bath dwelling, either renting or purchasing:

 

Home price $500,000                                                                    Rent per month $3,000

Loan:  $400,000                                                                                Renter’s Insurance per month $12

Downpayment $100,000                                                                              Total:  $3,012

Monthly taxes:  $630

Monthly Insurance:  $190

Monthly mortgage payment:  $2,729

Principal portion of payment: $312

Interest portion of payment: $2,417

Total monthly Cost (principal, interest, taxes, insurance)

$3,549

 

In this example, the cost of ownership is higher.  The monthly payment is $3,549 – $3,012 = $537 higher.

The extra cost of $537 is not compensated entirely by the principal reduction of $312.

Keep in mind, the cost of repairs is not factored into this example.  Some sources say expect annual repairs to be 1% -4% of the home’s value.  In our example that equates to $5,000 to $20,000 annually.  Obviously, these costs do not apply to renting.

In this example, perhaps renting makes more sense.  In time, the principal portion of the monthly payment will grow, making ownership more lucrative.  Knowing how long you intend to stay in the home is another key factor in determining whether renting or owning is best.